Annuities

Question 1

Terms

Answer 1

Deferred - withheld or postponed until a specified time or event in the future
IRS - Internal Revenue Service: a U.S. Government agency responsible for collecting of taxes, and enforcement of the Internal Revenue Code
Life contingency - dependent upon whether or not the insured is alive
Liquidation of an estate - converting a person’s net worth into a cash flow
Natural person - a human being
Qualified plan - a retirement plan that meets the IRS guidelines for receiving favorable tax treatment
Suitability - a requirement to determine if an insurance product or an investment is appropriate for a particular customer

Question 2

Annuity Principles and Concepts

Answer 2

Annuity Principles and Concepts
An annuity is a contract that provides income for a specified period of years, or for life. An annuity protects individuals against
outliving their money. Annuities are not life insurance, but rather a vehicle for the accumulation of money and the liquidation of an
estate. Annuities are marketed by life insurance companies. Licensed life insurance agents are authorized to sell some types of
annuities.
Annuities do not pay a face amount upon the death of the annuitant. In fact, they do just the opposite. In most cases, the payments
stop upon the death of the annuitant. Annuities use mortality tables, but these tables reflect a longer life expectancy than the
mortality tables used for life insurance. Mortality tables indicate the number of individuals within a specified group (e.g., males,
females, smokers, nonsmokers) starting at a certain age, who are expected to be alive at a succeeding age.

Question 3

1. Owner, Annuitant and Beneficiary

Answer 3

1. Owner, Annuitant and Beneficiary
   Owner - The purchaser of the annuity contract, but not necessarily the one who receives the benefits. The owner of the annuity has
   all of the rights, such as naming the beneficiary and surrendering the annuity. The owner of an annuity may be a corporation, trust, or
   other legal entity.
   Annuitant - The person who receives benefits or payments from the annuity, whose life expectancy is taken into consideration, and
   for whom the annuity is written. The annuitant and the contract owner do not need to be the same person, but most often are. A
   corporation, trust or other legal entity may own an annuity, but the annuitant must be a natural person.
   Know This! Because annuities are based on the life expectancy of an annuitant, the annuitant must be a natural person, regardless of
   who owns the policy.
   Beneficiary. - The person who receives annuity assets (either the amount paid into the annuity or the cash value, whichever is greater)
   if the annuitant dies during the accumulation period, or to whom the balance of annuity benefits is paid out.

Question 4

Accumulation Period vs. Annuity Period

Answer 4

Accumulation Period vs. Annuity Period
The accumulation period, also known as the pay-in period, is the period of time over which the owner makes payments (premiums)
into an annuity. Furthermore, it is the period of time during which the payments earn interest on a tax-deferred basis.
The annuity period, also known as the annuitization period, liquidation period, or pay-out period, is the time during which the sum that
has been accumulated during the accumulation period is converted into a stream of income payments to the annuitant. The annuity
period may last for the lifetime of the annuitant or for a specified period, which could be longer or shorter. The annuitization date is
the time when the annuity benefit payouts begin (trigger for benefits).

Know This! During the accumulation period, funds are paid INTO the annuity. During the annuity period, funds are paid OUT to the
annuitant.

Question 5

The annuity income amount is based upon the following:

Answer 5

The annuity income amount is based upon the following:
The amount of premium paid or cash value accumulated;
• The frequency of the payment;
• The interest rate: and
• The annuitant’s age and gender.
An annuitant whose life expectancy is longer will have smaller income installments. For example, all other factors being equal, a 65-
year-old male will have higher annuity income payments than a 45-year-old male (because he is younger), or than a 65-year-old
female (because women statistically have a longer life expectancy).
Know This! Shorter life expectancy = higher benefit; longer life expectancy = lower benefit.
If an annuitant dies during the accumulation period, the insurer is obligated to return to the beneficiary either the cash value or the
total premiums paid, whichever is greater. If a beneficiary is not named, the death benefit will be paid to the annuitant’s estate.
Annuities can be classified according to how premiums are paid into the annuity, how premiums are invested, and when and how
benefits are paid out.

Question 6

Classification of annuities:

Answer 6

Classification of annuities:
• Premium payment method: single premium vs. periodic
• When income payments begin: immediate vs. deferred
• How premiums are invested: fixed vs. variable
Disposing of proceeds: pure life, annuity certain, or life refund annuity

Question 7

Premium Payment Options

Answer 7

The first way to classify annuities can be based on how they can be funded (paid for). There are 2 options: a single premium (one-time
lump-sum payment) or through periodic payments in which the premiums are paid in installments over a period of time. Periodic
payment annuities can be either level premium, in which the annuitant/owner pays a fixed installment, or flexible premium, in which
the amount and frequency of each installment varies.

Question 8

Required Provisions

Answer 8

Required Provisions
Required provisions that apply to annuities are the same as those that apply to life insurance contracts (Review the following required
provisions: grace period, incontestability, entire contract, misstatement of age, free-look period, and other life insurance provisions).
The following are additional required provisions that apply to annuities:
• For every annuity (except those paid for by a single premium), if the contract has been in force for 3 years and lapses or becomes
defaulted because payment to the insurer has not been made, the insurer, after deducting a surrender charge and any
indebtedness, can apply the balance as a net single-premium for the purchase of a paid-up annuity.
• Annuities must be offered with nonforfeiture benefits under defaulted contracts: in the event of default in payment of a
premium, after an annuity contract has been in force for 3 full years, the insurer must pay a cash surrender value to the person
entitled within 3 months.
• Insurers will provide a statement of the mortality table (if any) and interest rates used in calculating any minimum paid-up annuity
or death benefits that are guaranteed under the contract, the times at which such guaranteed benefits are payable (along with
sufficient information to determine the amounts of such benefit), and whether the contract provides for the determination of any
cash surrender value in accordance with a market-value adjustment formula that has been filed with the Superintendent.
Market-value adjustment formulas are those described in the contract that increase and decrease the actual accumulation
amount in order to determine cash surrender values payable.
• For annuities other than single premium, paid-up contracts, the insurer will mail to the contract holder a statement regarding any
paid-up annuity benefit, any cash surrender benefit, and any death benefit.

Question 9

C. Immediate vs. Deferred Annuities

Answer 9

Annuities can also be classified according to when the income payments from the annuity begin. An immediate annuity is one that is
purchased with a single, lump-sum payment and provides income payments that start within one year from the date of purchase.
Typically, an immediate annuity will make the first payment as early as 1 month from the purchase date. Most commonly, this type of
annuity is known as a Single Premium Immediate Annuity (SPIA).
A deferred annuity is an annuity in which the income payments begin sometime after one year from the date of purchase. Deferred
annuities can be funded with either a single lump sum (Single Premium Deferred Annuities - SPAs) or through periodic payments
(Flexible Premium Deferred Annuities - FPDAs). Periodic payments can vary from year to year. The longer the annuity is deferred, the
more flexibility for payment of premiums it allows.
Know This! An immediate annuity is purchased with a single premium.
Know This! Income payments from a deferred annuity begin sometime after 1 year from the date of purchase.

Question 10

Nonforfeiture

Answer 10

Nonforfeiture
The nonforfeiture law stipulates that a deferred annuity must have a guaranteed surrender value that is available if the owner decides
to surrender the annuity prior to annuitization (e.g., 100% of the premium paid, less any prior withdrawals and related surrender
charges). However, a 10% penalty will be applied for early withdrawals (prior to age 59 ½).

Question 11

2. Surrender Charges

Answer 11

2. Surrender Charges
The purpose of the surrender charge is to help compensate the company for loss of the investment value due to an early surrender of
a deferred annuity.
A surrender charge is levied against the cash value, and is generally a percentage that reduces over time. A common surrender
charge might be 7% the first year, 6% the second year, and 5%, 4%, 3%, 2%, 1%, and 0% respectively thereafter. Therefore, if the
annuity is surrendered in the 8th year or after there would be no further surrender charge. At surrender, the owner gets the premium
plus interest (the value of the annuity), minus the surrender charge.

Example:
Assume that the annuity owner paid $700 in premium, which accumulated a total of $35 of interest, and a surrender charge is $70. If
the annuity is surrendered prematurely, what will the annuity value be at surrender? The answer is $665.
($700 Premium + $35 Interest) - $70 Surrender Charge = $665 Value of the Annuity.

Question 12

Annuity Benefit Payment Options

Answer 12

Annuity Benefit Payment Options
Annuity, payment options specify how annuity funds are to be paid out. They are very similar to the settlement options used in life
insurance that determine how the policy proceeds are distributed to the beneficiaries.

Question 13

1. Life Contingency Options - Pure or Straight Life vs. Life with Guaranteed Minimum

Answer 13

1. Life Contingency Options - Pure or Straight Life vs. Life with Guaranteed Minimum
   The life annuity will pay a specific amount for the remainder of the annuitant’s life. With pure life, also known as life-only or straight
   life, this payment ceases at the annuitant’s death (no matter how soon in the annuitization period that occurs). This option provides
   the highest monthly benefits for an individual annuitant. Under this option, while the annuity payments are guaranteed for the lifetime
   of the annuitant, there is no guarantee that all the proceeds will be fully paid out.
   Under the life with guaranteed minimum settlement option, if the annuitant dies before the principal amount has been paid out, the
   remainder of the principal amount will be refunded to the beneficiary. This option is also called refund life. It guarantees that the entire
   principal amount will be paid out.
   Know This! Pure life annuity provides the highest monthly benefit, but there is no guarantee that the entire principal will be paid out.
   There are two types of refund life annuities:
   • Cash refund - when the annuitant dies, the beneficiary receives a lump-sum refund of the principal minus benefit payments
   already made to the annuitant. Cash refund option does not guarantee to pay any interest.
   • Installment refund - when the annuitant dies, the beneficiary will continue to receive guaranteed installments until the entire
   principal amount has been paid out.
   Note, however, that any unpaid annuity benefits following the death of an annuitant are taxable when paid to the beneficiary.
   Life with period (term) certain is another life contingency payout option. Under this option, the annuity payments are guaranteed for
   the lifetime of the annuitant, and for a specified period of time for the beneficiary. For example, a life income with a 20-year period
   certain option would provide the annuitant with an income while he is living (for the entire life). If, however, the annuitant dies shortly
   after payments begin, the payments will be continued to a beneficiary for the remainder of the period (for a total of 20 years).

Question 14

Single Life vs. Multiple Life

Answer 14

Single Life vs. Multiple Life
Single life annuities cover one life, and annuity payments are made with reference to one life only. Contributions can be made with a
single premium or on a periodic premium basis with subsequent values accumulating until the contract is annuitized.
Multiple life annuities cover 2 or more lives. The most common multiple life annuities are joint life, and joint and survivor.

Question 15

Joint Life

Answer 15

Joint Life
Joint life is a payout arrangement where two or more annuitants receive payments until the first death among the annuitants, and
then payments stop.

Question 16

Joint and Survivor

Answer 16

Joint and Survivor
The joint and survivor arrangement is a modification of the life income option in that it guarantees an income for two recipients that
neither can outlive. Although it is possible for the surviving recipient(s) to receive payments in the same amount as the first recipient
to die, most contracts provide that the surviving recipients will receive a reduced payment after the first recipient dies. Most
commonly, this option is written as “joint and ½ survivor” or “joint and 2/3 survivor,” in which the surviving beneficiary receives ½ or
2/3 of what was received when both beneficiaries were alive. This option is commonly selected by a couple in retirement. As with the
life income option, there is no guarantee that all the proceeds will be paid out if both beneficiaries die shortly after the installments
begin.

Question 17

Annuities Certain (Types)

Answer 17

Annuities Certain (Types)
In contrast with life contingency benefit payment options, annuities certain are short-term annuities that limit the amounts paid to a
certain fixed period or until a certain fixed amount is liquidated.

Question 18

Fixed Period

Answer 18

Fixed Period
With fixed-period installments, the annuitant selects the time period for the benefits, and the insurer determines how much each
payment will be, based on the value of the account and future earnings projections. This option pays for a specified amount of time
only, whether or not the annuitant is living.

Know This! The fixed-period option pays for a specific time only, whether or not the annuitant is living.

Question 19

Fixed Amount

Answer 19

Fixed Amount
With fixed-amount installments, the annuitant selects how much each payment will be, and the insurer determines how long the
benefits will be paid by analyzing the value of the account and future earnings. This option pays a specific amount until funds are
exhausted, whether or not the annuitant is living.

Question 20

Annuity Products - Annuity Investment Options

Answer 20

Annuity Products - Annuity Investment Options

Annuities may be classified as fixed or variable based on how the premium payments are invested.

Question 21

1. Fixed Annuities

Answer 21

1. Fixed Annuities
   A fixed annuity provides the following features:
   • Guaranteed minimum rate of interest to be credited to the purchase payment(s);
   • Income (annuity) payments that do not vary from one payment to the next; and
   • The insurance company guarantees the specified dollar amount for each payment and the length of the period of payments as
   determined by the settlement option chosen by the annuitant.
   With fixed annuities, the annuitant knows the exact amount of each payment received from the annuity during the annuity period.
   This is called level benefit payment amount. A disadvantage to fixed annuities is that the purchasing power that they afford may be
   eroded over time due to inflation.
   General Account Assets
   Fixed annuity premiums are deposited into the life insurance company’s general account. The general account is comprised mostly of
   conservative investments like bonds. These investments are secure enough to allow the insurance company to guarantee a specified
   rate of interest, as well as assure the future income payments that the annuity will provide.
   Know This! In fixed annuities, the premiums are deposited in the company’s general account.
   Interest Rate Guarantees (Minimum vs. Current)
   In fixed annuities, the insurer bears the investment risk. Future interest rates actually paid by an insurer are based upon the
   performance of the insurance company’s general account. However, the rate may not drop below a policy’s guaranteed minimum
   (typically 3%). Should interest rates drop below this guaranteed rate, the insurer is obligated to pay the guaranteed rate amount.
   During the accumulation phase, the insurer will invest the principal, or accumulation, and give the annuitant a guaranteed interest rate
   based on a minimum rate as specified in the annuity, or the current interest rate, whichever is higher. The minimum rate is the lowest
   rate that the principal can contractually earn.
   Equity Indexed Annuities
   Indexed (or equity indexed annuities are fixed annuities that invest on a relatively aggressive basis to aim for higher returns. Like a
   fixed annuity, the indexed annuity has a guaranteed minimum interest rate. The current interest rate that is actually credited is often
   tied to a familiar index like the Standard and Poor’s 500.

Question 22

Interest Rate Guarantees (Minimum vs. Current)

Answer 22

Interest Rate Guarantees (Minimum vs. Current)
In fixed annuities, the insurer bears the investment risk. Future interest rates actually paid by an insurer are based upon the
performance of the insurance company’s general account. However, the rate may not drop below a policy’s guaranteed minimum
(typically 3%). Should interest rates drop below this guaranteed rate, the insurer is obligated to pay the guaranteed rate amount.
During the accumulation phase, the insurer will invest the principal, or accumulation, and give the annuitant a guaranteed interest rate
based on a minimum rate as specified in the annuity, or the current interest rate, whichever is higher. The minimum rate is the lowest
rate that the principal can contractually earn.
Equity Indexed Annuities
Indexed (or equity indexed annuities are fixed annuities that invest on a relatively aggressive basis to aim for higher returns. Like a
fixed annuity, the indexed annuity has a guaranteed minimum interest rate. The current interest rate that is actually credited is often
tied to a familiar index like the Standard and Poor’s 500.

Question 23

Equity Indexed Annuities

Answer 23

Equity Indexed Annuities
Indexed (or equity indexed) annuities are fixed annuities that invest on a relatively aggressive basis to aim for higher returns. Like a
fixed annuity, the indexed annuity has a guaranteed minimum interest rate. The current interest rate that is actually credited is often
tied to a familiar index like the Standard and Poor’s 500.
Generally, the insurance companies reserve the initial returns for themselves but pay the excess to the annuitant. For example, the
company may keep the first 4% earned for itself, but any accumulation in excess of 4% is credited to the annuitant’s account. So if the
interest earned is 12%, the company keeps 4% and credits the client’s account with 8%.
Equity indexed annuities are less risky than a variable annuity or mutual fund but are expected to earn a higher interest rate than a
fixed annuity.

Question 24

Variable Annuities

Answer 24

Variable Annuities
A variable annuity serves as a hedge against inflation, and is variable from the standpoint that the annuitant may receive different
rates of return on the funds that are paid into the annuity. Listed below are the 3 main characteristics of variable annuities:
• Underlying Investment: the payments that the annuitant makes into the variable annuity are invested in the insurer’s separate
account, not their general account. The separate account is not part of the insurance company’s own investment portfolio, and is
not subject to the restrictions that are applicable to the insurer’s own general account.
• Interest Rate: issuing insurance company does not guarantee a minimum interest rate.
• License Requirements: a variable annuity is considered a security and is regulated by the Securities Exchange Commission (SEC)
in addition to state insurance regulations. An agent selling variable annuities must hold a securities license in addition to a life
insurance license. Agents or companies that sell variable annuities must also be properly registered with FINRA.
Variable premiums purchase accumulation units in the fund, which is similar to buying shares in a Mutual Fund. Accumulation units
represent ownership interest in the separate account. Upon annuitization, the accumulation units are converted to annuity units. The
income is then paid to the annuitant based on the value of the annuity units. The number of annuity units received remains level, but
the unit values will fluctuate until actually paid out to the annuitant.

Question 25

Personal Uses of Annuities

Answer 25

Personal Uses of Annuities
The principal use of an annuity is to provide income for retirement; however, an annuity may be used for any accumulation of cash or
simply to liquidate an estate. Because of the various uses of annuities, agents should always assess how well a recommended
product will meet the applicant’s needs and resources - the suitability of a product.
Know This! The main use of annuities is to provide retirement income.

Question 26

1. Lump-Sum Settlements

Answer 26

1. Lump-Sum Settlements
   Annuities may serve as an ideal financial vehicle for someone who comes into a large lump sum of money, such as inheritance, lottery,
   award of damages from a lawsuit, proceeds from a sale of a business, or a lump-sum distribution from a qualified pension plan. In this
   case, a person may purchase a single premium immediate annuity, which will convert the lump sum into a series of periodic payments,
   providing a stream of income for the annuitant.

Question 27

Retirement Income

Answer 27

Retirement Income
Since annuities are a popular means to provide retirement income, they are often used to fund qualified retirement plans, which
means they meet the IRS guidelines to receive favorable tax treatment.
Qualified retirement annuities can be individual (such as individual retirement accounts - IRAs), and group (such as tax-sheltered
annuity - TSA, or profit-sharing pension plans).
Guaranteed Minimum Withdrawal Benefit
Retirement annuities may offer a Guaranteed Minimum Withdrawal Benefit (GMWB) option to the annuitant. With this option, the
annuitant can withdraw a maximum percentage of his or her investment annually until the initial investment has been recovered. This
option protects the annuitant against investment losses.

Question 28

Education Funds

Answer 28

Education Funds
In addition to providing income for retirement and estate liquidation, annuities can be used to accumulate funds for college education.
An annuity can provide savings on a tax-deferred basis for the education expenses of the annuitant.